Rebuilt biz is more resilient

Media congloms' refocus has made them stronger

The stock market has swooned and Wall Street fears a double-dip recession, but Hollywood has managed to stay above the doomsday fray — at least for the moment.

And despite signs here and there of gathering storm clouds, the majors are churning out profits, their sibling basic cable networks remain proven moneyspinners in a weak economy and their parent media congloms have mostly divested their low-growth businesses.

The sustainability of Hollywood in a sour economy is no accident. Over the years, company after company has made strategic decisions — sometimes painful ones involving shutdowns and layoffs — to bolster the bottom line

For the studios, one of the paths to sustained profitability has been the shedding of their specialty film units, a measure that over the past few years has helped reduce overhead.

And since the recession of 2008, they’ve also been more tight-fisted when it comes to star salaries and paying talent — an action that’s likely to stick. “These companies are not going to revert to their old cost overhead simply because the economy may get better,” says Tuna Amobi, media/entertainment analyst at Standard & Poors. “The old ways of doing business are out the door.”

Offloaded specialty units include Miramax, the indie arm Disney sold in late 2010 to a private equity buyer, narrowing the parent company’s focus to large mainstream films, Amobi says. Since the major studios began this kind of restructuring nearly three years ago, they’ve raised their operating profit margins from a meager 3%-7% to 10%-20%.

While the congloms may find that gratifying, Amobi notes that they can take even greater pleasure in the performance of their basic cable networks, which routinely post profit margins in the high 30% to low 40% range.

The media congloms also streamlined themselves by unloading poorly performing or low-growth businesses. For example, Time Warner spun off struggling AOL, and News Corp. sold some of its owned-and-operated broadcast TV stations. That’s a giant shift from the boom days of past decades when media businesses were carrying high valuations, prompting the congloms to buy magazines and TV stations — properties only to be shed later, in some cases.

Some have also jacked up quarterly cash dividends paid to investors, a path pursued by CBS and NBCUniversal majority owner Comcast.

For several years they’ve also been doing other types of major corporate re-engineering. Back in 2006, Viacom raised eyebrows by splitting itself into two companies — Viacom and CBS. In June, Cablevision Systems spun off its cable networks into AMC Networks.

Wall Street tends to value every $10 million in cash flow from multichannel TV platforms such as cable systems at $40 million to $70 million. The value rises to $80 million to $100 million if the cash flow is generated by high-growth basic cable networks, according to market multiples for media assets compiled by investment house Gabelli & Co.

Value can be found in other places as well, including the above-mentioned structural changes. “We’ve seen Cablevision achieve improvement in surface value by separating into different parts,” says Brett Harriss, research analyst at Gabelli & Co. “Surface value” refers to Wall Street assigning a higher price because of a change in the structure of a company even though the underlying financials are unchanged.

But despite all these positive measures, the outlook for media companies is not entirely rosy.

The advertising business, which provides a large share of most media congloms’ revenues, would be hurt by the second half of a double-dip recession, just as it suffered during the steep dip of 2008-2009.

Additionally, DVD sales continue to slump. The phenom is unlikely to turn around because consumers are abandoning physical media for digital downloads and streaming, and the growth in online revenue for filmed entertainment is so far not strong enough to take up the slack.

Another worry: After driving valuations for media conglomerates for years, basic cable networks such as CNN, FX and MTV are maturing in the U.S. Opinions vary as to whether basic cable’s robust profits are in any immediate danger.

“The cable networks got hammered in the recession along with everyone else,” says Derek Baine, senior analyst at researcher SNL Kagan. “But if you looked at the actual financials, their ad revenue was only flat to down maybe 1%, and license fees were actually up 8%-10% at a lot of networks. I think that fully distributed basic cable networks will still be able grow cash flow 5% to 8% (even though they’re maturing). It’ll still a pretty decent business,” particularly since they’re tapping international.

Hal Vogel, president of Vogel Capital Management, is more cautious. “My take is that growth is going to slow dramatically over the next few years,” he says. “That will tend to reduce the multiples (on earnings) of the media conglomerates. The basic cable networks have been the motor for valuation expansion in recent years.”

While the major movie studios have improved their business through cost cutting and by paring medium and small film releases, investors still are cautious about assigning them high valuations because profitability is volatile. Unlike advertising demand, the ebb and flow of the motion picture business does not follow the general economic cycle. Instead, it’s mostly linked to hit films and to new media technologies spawning additional buyers.

” ‘Avatar’ is the most visible example of a movie that made a billion dollars, to which investors ask, what else does a company have that can do as well next year?” says Jeff Logsdon, managing director at BMO Capital Markets. “The answer is probably nothing, although something comparable may come along in a five or 10 years. Success almost works against film companies with investors who are always looking to year-to-year comparisons.”